Wary of risk? There are steps to take

The move is on to risk-free investing. At least that's what financial planners say many clients are seeking.

Trouble is, there's no such thing as truly risk-free investing. Interest rates, inflation and market movements always conspire to serve up surprises for any portfolio.

The best anyone can do is offer some ways to guard against adversity and spread risk. Buying blue-chip stocks or sticking with certificates of deposit can't do it alone, which is why life-cycle funds, selling of covered calls and laddering of bonds have been heavily discussed this year.

There is also increased emphasis on lower expenses, which is why low-cost mutual fund families such as T. Rowe Price and Vanguard are in the spotlight.

"I had a 72-year-old client who came in with every one of his investments an individual stock, which I considered amazing exposure to equity risk," said Bonnie Ashby Hughes, certified financial planner and principal of A & H Financial Planning and Education Inc. in Chattanooga, Tenn. "I would be much more comfortable with the predictability of a life-cycle fund in which you'll always know your exposure to stocks in a given year."

Life-cycle funds, also known as target retirement funds, evolve with your age. Using a portfolio of stocks, bonds and cash, the stock portion generally decreases as you move closer to retirement.

T. Rowe Price Retirement 2010 and T. Rowe Price Retirement 2035 are examples of low-cost, reliable life-cycle funds, Ashby Hughes said. The first has a three-year annualized return of 10 percent with 64 percent of its portfolio in equities. The latter has only been around long enough to have a 12-month return of 6 percent. It has 89percent of portfolio in equities.

Although Jerome Clark, portfolio manager of both funds, increases his allocation to bonds and cash as years go by, his large holdings of stock are more aggressive than many of their peers, in acknowledgment of the potential life span of investors.

"The biggest risk facing investors is miscalculating their longevity and being too conservative, thinking once they're retired at 65 they can put everything in short-term instruments such as CDs or money markets," said Fran Kinniry, a principal in Vanguard's investment Counseling and Research Group. "Statistics show you could be 30 or 40 years in retirement, which means a balanced portfolio of stocks, bonds, money markets and CDs is a better approach."

Investors face not only risk of lost principal, but lost income as well, she said.

"From 1980 through 1999 interest rates went from 18 percent all the way down to 4 percent, and that gravy train is certainly over," Kinniry said. "Now we think bonds will get about half the returns they did in the last 20 years--5 percent instead of 10 percent--so costs are the primary differential between a winning and a losing bond strategy."

For example, Vanguard Target Retirement 2035, aimed at those retiring 25 to 35 years from now, is one of that family's targeted funds that features a low annual expense ratio of 0.20 percent. That fund is up 1 percent this year, following a gain of 6 percent last year.

A growing number of individual investors are turning to options contracts as a conservative move. Selling a covered call earns you cash in exchange for giving somebody else the right to buy (call away) your shares at a preset price over a certain time frame. The extra cash can reduce the downside risk of your shares, but the fact that they can be called if the market rises limits your potential gain.

Sound complicated? Some funds specialize in this for you.

"The object of a covered call-writing strategy is to provide the investor with a majority of equity returns available in the broad market, but with less volatility, which means less risk," said Robert Straus, portfolio manager of ICON Covered Calls Fund I, which has a three-year annualized return of 6 percent. "If you're an investor who wants to be in equities but has a hard time riding through volatile periods, this helps you participate in the upside without as much volatility as a pure equity fund."

"Someone in a 30 percent individual tax bracket earning 3.5 percent in CDs with inflation running close to 4 percent is losing money," said Harold Evensky, a certified financial planner with Evensky & Katz in Coral Gables, Fla. "The solution is laddering, the process in which you buy a short-term bond fund, a short intermediate bond fund with bonds maturing in three to five years and an intermediate bond fund with bonds maturing in five to 10 years."

When rates go up, your short-term money will go up with them, while if rates go down you've got some longer-term returns locked up, Evensky said.

For a conservative portfolio, Evensky recommends 60 percent stocks and 40 percent bonds. He'd start the stock portion with the Vanguard 500 Index, which has a three-year annualized return of nearly 10 percent.